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CAIIB-ABM-MOD-D-Interest Rate Risk Management

Interest Rate Risk Management

  • Interest rate risk is the exposure of a bank's financial condition to adverse movements in interest rates.
  • Gap: The gap is the difference between the amount of assets and liabilities on which the interest rates are reset during a given period.
  • Interest rate risk refers to volatility in Net Interest Income (NiI) or in variations in Net Interest Margin (NIM)
  • The degree of basis risk is fairly high in respect of banks that create composite assets out of composite liabilities.
  • The risk that the interest rate of different assets and liabilities may change in different magnitudes is called basis risk.
  • When assets and liabilities fall due to repricing in different periods, they can create a mismatch. Such a mismatch or gap may lead to gain or loss depending upon how interest rate in the market tend to move.
  • The degree of basis risk is fairly high in respect of banks that create composite assets out of composite liabilities
  • When the variation in market interest rate causes the Nil to expand, the banks have experienced a favourable basis shift and if the interest rate movement causes the Nil to contract, the basis has moved against the bank.
  • An yield curve is a line on a graph plotting the yield of all maturities of a particular instrument
  • Price risk occurs when assets are sold before their maturity dates.
  • The price risk is closely associated with the trading book which is created for making profit out of short-term movements in interest rates.
  • Uncertainty with regard to interest rate at which the future cash flows can be reinvested is called reinvestment risk.
  • When the interest rate goes up, the bonds price decreases
  • When the interest rate declines the bond price increases resulting in a capital gain but the realised compound yield decreases because of lower coupon reinvestment income.
  • Duration is a measure of the percentage change in the economic value of a position that will occur, given a small change in the level of interest rates.
  • Higher duration implies that a given change in the level of interest rates will have a larger impact on economic value.
  • Interest Rate Sensitive Gap: Interest Rate Sensitive Assets(RSA) - Interest Rate Sensitive Liabilities (RSL).

  • Positive Gap or Asset Sensitive Gap - RSA - RSL > 0 & Negative Gap or Liability Sensitive - RSA - RSL < 0


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